Current deduction allowed for pipeline relocation expense.

The Tax Court in Badger Pipe Line Co., TC Memo 1997-457, ruled that a petroleum pipeline corporation could deduct costs associated with relocating and replacing 1,000 feet of pipeline, because these costs were commonly incurred in the corporation's normal course of business and were necessary to keep the pipeline in working order. To reach this result, the court applied the test found in Plainfield Union Water Co., 39 TC 333 (1962), and concluded that the pipe relocation did not materially add to the pipeline's value nor appreciably prolong its life.

At issue was a section of the Badger Pipeline Company's (Badger) pipeline located within an Illinois Department of Transportation (IDOT) right-of-way. Pipeline companies are routinely granted permits to locate pipelines within a right-of-way. Such permits generally provide that if the pipeline interferes with the use of the right-of-way, the permit holder is responsible for any costs associated with relocating the pipeline. Due to a highway improvement project, Badger was required to relocate approximately 1,000 feet of a 25-mile pipeline. The relocation was performed by Badger to comply with its obligation under the permit from IDOT and to continue use of the pipeline in the ordinary and normal course of its business.

Because it was not feasible to stop the pipeline flow during the relocation, Badger dug new trenches, installed replacement pipe and diverted the How to the relocated portion. The original pipe was replaced with new pipe; the used pipe (which was determined to be reusable) was taken to one of Badger's storage facilities. Badger did not retire the used pipe or remove its undepreciated costs from the company's books.

Citing INDOPCO Inc., 503 US 79 (1992), the Tax Court acknowledged that in determining the appropriateness of a current deduction, it is important to consider whether the taxpayer will realize benefits beyond the year in which the expense is incurred. However, the court concluded that INDOPCO "is not an absolute rule, since the benefits of expenditures considered to be currently deductible, such as repairs, for example, often extend beyond the current year."

The court applied the test enunciated in Plainfield Union in determining if Badger's pipeline relocation costs were currently deductible. Plainfield Union provides that the proper test for deductibility is "whether the expenditure materially enhances the value, use, life expectancy, strength, or capacity as compared with the status of the asset prior to the condition necessitating the expenditure." Applying this test to Badger's facts, the court found that the relocation was simply to keep the pipeline in its normal, ordinary and efficient operating condition. The court found two facts significant: only 1,000 feet of the 25-mile pipeline was relocated; and the relocation was necessary to avoid disruption of Badger's entire pipeline system. Thus, the costs associated with relocating the pipeline were deductible.

This case is important because the court limited the potential application of INDOPCO by stating that the future benefit rule in INDOPCO is not "absolute." It is also significant that the Tax Court relied on the Plainfield Union test to determine deductibility. Although Plainfield Union was decided over 35 years ago, it has not been consistently applied to determine whether costs are deductible. Badger Pipe Line may signal that the test will be used more frequently in future decisions.

FROM DIANE P. HERNDON, WASHINGTON, D.C.